What’s a correction?
A “correction” happens when an asset, an index, or an entire market falls 10% or more from its most recent high. And they typically last from days to months.
On Monday Jan 24th 2021 , the S&P 500 index was in jeopardy of closing in correction territory, but staged a turnaround with the broader market. The broad-market index needs to close above 4,316.90 to avoid a fall of 10% from its Jan. 3 record close.
On Thursday Jan 27th 2021 , The S&P 500 (.SPX) closed down but narrowly avoided a correction confirmation, after a session of gymnastic volatility that had the benchmark index advancing throughout the morning and gyrating below Wednesday’s closing level in afternoon trading. It closed the session just 10 points higher than what would officially have been deemed a correction, if it closed 10% below its most recent record close.
The small cap Russell 2000 (.RUT) however did confirm that it was in a bear market, closing down 2.3% on the day and more than 20% below its Nov. 8 closing high.
Nasdaq ($QQQ) — which mostly measures US tech stocks — has fallen 15% from its late November record through yesterday.
While they can be painful short-term, they’re normal for markets and can help reset pricier assets. Zooming out: The Nasdaq has had 66 corrections since 1971.
The index has registered a correction 65 times (not including Wednesday’s) since it was launched in 1971, and of those corrections, 24 of them, or 37%, have resulted in bear markets, or declines of at least 20% from a recent peak, according to Dow Jones Market Data.
More recently, corrections have served as buying opportunities, with the sojourn into correction territory on March 8 resulting in subsequent gains for the one-week, two-week, three week and one-month periods, going all the way out to six months. A similar uptrend took hold when the Nasdaq Composite slipped into correction territory in early September 2020.
Why are we in correction?
Lots of factors play into corrections, but this one is mostly related to inflation and interest rates. Let’s unpack that…
• Inflation… is at a 40-year high. To tame soaring prices (think: oil at the pump, bacon at checkout), the Fed is expected to hike interest rates multiple times this year. ETA: as soon as March.
• Rising rates… can be bad for growth stocks like tech. Higher rates can make US government bonds and savings accounts more attractive vs. riskier assets like tech — whose share prices are often driven by expected future growth. As rates and inflation rise, the value of a company’s potential growth falls.
• Also… some companies that thrived during the pandemic have seen earnings slow this year, like tech stocks and banks – playing into the correction.
$QQQ: Tech shares soared during the pandemic while the Fed slashed interest rates to zero to fuel the economy. Now that inflation keeps rising, the Fed is ending the stimulus party — and frothy valuations are being “corrected.”
What could be the takeaway for retail investors?
It depends on your strategy and other factors like your age, finances, and risk tolerance. For some long-term investors, corrections can be a temporary dip toward reaching investing goals. Portfolios that are diversified across different types of industries and investments can be less affected by corrections when certain assets decline.
Of course, even if the market recovers, there’s never a guarantee that individual stocks or portfolios will follow the same trajectory. Though some recoveries took longer than others, historically the US market has bounced back from corrections over time.
History of market corrections –
